Greece is the word

Since Tom White’s article “A Very Modern Greek Tragedy” at the end of January, the eurozone’s treatment of Greece has been a very delicate balancing act. The last thing the European authorities want is to do is reprieve Greece. Not only would this send the wrong signal to the so-called PIGS (Portugal, Ireland, Italy, Greece and Spain, the countries earmarked for future problems), it would also seem to condone the terrible fiscal management of the Greek government over the past decade.

On the other hand, without such measures there is the distinct possibility that Greek debt could be downgraded, which would wreak havoc throughout their financial system, and more worryingly the rest of Europe, not to mention the thought of a default, which would put a chill down the spine of even the most hardened eurozone official. So what can be done?

Despite a strict ‘no bail-out’ policy the European Central Bank (ECB) has been giving Greece backhanders throughout the present crisis. By accepting lower rated government bonds as collateral for credit the ECB has been able to pump an abundance of cheap money into the Greek economy.

This is probably the major reason why the problem surfaced only recently and not a year ago. However, this strategy is far too risky to become anything permanent, which the ECB has finally had to concede by refusing to accept anything lower than A- collateral, which lies above Greece’s current BBB+ rating.

Further debt downgrades for Greece could cause extreme problems, something that has been reflected in the markets over the past few months. What is needed in Europe is a transparent mechanism to deal with the next Greek tragedy. Fortunately it looks like such a system could be on the horizon.

The idea of a European Monetary Fund (EMF) has resurfaced for the first time since 1978 when it was postulated as a way for countries that are hit by sudden crises to draw on resources, conditioned by formal policy restrictions.

Initial details of the EMF, introduced by German finance minister Wolfgang Schäuble, indicate that it would play a similar role to the one suggested in the seventies, acting as a lender of last resort for countries in fiscal difficulty, very similar to the current IMF.

This could be a valuable tool for two reasons. First, it would lay down established procedures that a country must meet in order to receive aid – thereby reducing the moral hazard issue as countries would have an incentive to undertake responsible fiscal management. Second, it would depoliticise the search for funds as black and white rules would be in place. The sight of Greek Prime Minister George Papandreou touring Europe to drum up support would become something of the past.

Europe must overcome some serious problems though. Angela Merkel, the German chancellor, has warned that a new EU treaty would be needed, which is potentially divisive given the lengthy approval process for the Lisbon treaty. However two years on there seems to be broad support throughout Europe for the creation of an EMF.

We must not nevertheless fool ourselves into thinking that this is a silver-bullet that can be fired any time soon. Whether an EMF is created or not, it will only play a reactive role in future crises, not a preventative role. Therefore, without balanced growth and competitiveness throughout the eurozone, there may be a few more Greek tragedies to come.